I had occasion over the past few days to talk with several people on the LBO side of Wall Street, and while none of the revelations below will be particularly surprising to those in the business, they certainly may be a surprise to those neophyte investors who are still long tech stocks and don't understand that a serious problem is brewing in our fixed income markets.

You see, just off our equity highs, the junk bond market has already ceased to exist -- few deals going through, no one making prices, no liquidity whatsoever.

Moreover, credit spreads have been steadily widening since late January, driven in part by Treasury specific redemptions and congressional hearings on FNMA and GNMA quasi-government funding levels, but driven as well by traditional credit fears as the U.S. economy becomes a bit more fragile.

The chart below is of 30-year Treasuries against equivalent maturity GNMA mortgage-backed securities. Since late January the picture is not a pretty one.

U.S. 30-Year Treasuries vs 30-Year GNMAs
Source: Bloomberg

The spread between 10-year Treasury note yields vs 10-year swap spreads is equally as troublesome.

U.S. 10-Year Treasuries vs 10-Year Swaps
Source: Bloomberg

We are now trading at levels on both of these spreads above those witnessed during the Russian default crisis of 1998! And the pictures above do not include several basis points of further widening Thursday.

Now in an economy driven and maintained by the extention of credit, the movement in these spreads is like a warning shot across the equity market bow that the easy days are over, and that a day of reckoning on the overborrowed consumer may soon be at hand. When credit spreads are widening, Wall Street basically stops functioning as people expect it to, and bank stocks fall. Of course, the average momentum-oriented day-trader hardly ever looks at something this esoteric, so the fact that trouble has been brewing since January has really only been absorbed by Wall Street types. In recent weeks it thus not surprising to have seen institutions handing equity block trades to the public in droves. It's like the milk turning sour already while the poorly informed still contemplate making delicious ice cream.

I'd give it all no more than a year before we have congressional hearings on exactly what came undone.

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Sand Spring Advisors provides information and analysis from sources and using methods it believes reliable, but cannot accept responsibility for any trading losses that may be incurred as a result of our analysis. Individuals should consult with their broker and personal financial advisors before engaging in any trading activities, and should always trade at a position size level well within their financial condition. Principals of Sand Spring Advisors may carry positions in securities or futures discussed, but as a matter of policy will always so disclose this if it is the case, and will specifically not trade in any described security or futures for a period 5 business days prior to or subsequent to a commentary being released on a given security or futures.